China's inflation problem

Producer and consumer prices are diverging - which could spark trouble in the future.

China’s economic data have long been looked upon with a hint of suspicion. Inflation data is considered to be one of the better economic indicators produced by the China’s National Bureau of Statistics, however, recent outcomes have raised some questions. The producer price index (PPI) is considered to be a relatively reliable leading indicator of the consumer price index (CPI), as upstream price pressures, including the effect of higher commodity prices and raw materials, eventually trickle down and feed through to consumer prices. History has shown that it is broadly the case for China, with the CPI and PPI moving roughly in line with each other.

However, comparing the recent inflation outcomes at the consumer and producer level suggest a wide divergence in price pressures: rising consumer prices and falling producer prices in annual terms. The PPI has trended sharply downwards over the past year, down in deflationary territory for two consecutive months in April, while consumer prices have moderated more slowly. Growth in the CPI was 3.4 per cent in April 2012, moderating from a high of 6.5 per cent in July 2011, while the PPI which measures the selling price of goods and services sold at the wholesale level fell by 0.3 per cent in annual terms down from 7.5 per cent annual growth.

To some extent, the large recent falls in the PPI relates to a base effect; previously strong monthly increases in the index in late 2010 to early 2011 would reduce the magnitude of change in the index this year. But looking at the index rather than the growth, producer prices have also been subject to deflationary pressure in monthly terms – causing the index to fall slightly in late 2011, before more recently picking up.

The moderation in the PPI also reflects slackness in the manufacturing industry, where prices in the sector have fallen in annual terms for four consecutive months to be lower by 2.2 per cent in April 2012 compared to a year ago. This is in line with the continued moderating trend in industrial production, down to below 10 per cent annual growth in April – representing the weakest growth since the 2008-09 slowdown. Meanwhile, consumer prices have been driven largely by high food prices, which accounts for around one-third of the consumer basket.

The divergence between consumer and producer prices also highlights different operating conditions for upstream and downstream manufactures. Input prices have risen significantly, suggesting that profit margins for upstream manufacturers are taking a hit. Commodity prices have remained elevated; wage pressures have intensified with minimum wages rising by around 20 per cent annually in many provinces, while exchange rate appreciation has also cut into manufacturer’s profit. Anecdotes suggest that many exporters are declining large overseas orders, given the lack of skilled workers, tight credit conditions stemming from the government’s ‘prudent monetary policy’ and uncertainty over the pace of renminbi appreciation.

On the other hand, however, downstream manufacturers, which are less vulnerable to higher input prices, appear to be experiencing an improvement in their profit margins due to the positive gap between consumer and producer price inflation. Looking at reported profits across industries, consumer-related sectors appear to be best performers. In the three months to March, profits of automobile manufacturers increased by 6.3 per cent annually, while profits in the sectors of raw chemical and chemical products fell by 23.1 per cent and even further for ferrous metal mining and processing (down 83.5 per cent).

Looking ahead, it is expected that the gap between producer and consumer prices will eventually close in the coming months on the back of an improvement in manufacturing demand and possible relaxation of government credit restrictions. As per the government’s inflation target, consumer price inflation is set to average 4 per cent in 2012, which would mean relatively strong monthly growth of around 0.4 per cent over the remainder of this year. Should this be achieved, producer prices will need to rise at a much faster pace in accordance with the consumer and producer price relationship.

Until the figures get back on track, it is not unreasonable to expect the concerns felt in many countries about the accuracy of inflation numbers might well spread to China. Trying to get representative prices for a basket of goods that reflects the experiences of the majority is increasingly hard in complex economies prompting many to question the accuracy of one of the most important economic variables.

Chinese workers assemble electronics. Photograph: Getty Images

Niloofar Rafiei is China economist at Timetric, provider of economic data visualisation and analysis.

Photo: Getty
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Scotland's vast deficit remains an obstacle to independence

Though the country's financial position has improved, independence would still risk severe austerity. 

For the SNP, the annual Scottish public spending figures bring good and bad news. The good news, such as it is, is that Scotland's deficit fell by £1.3bn in 2016/17. The bad news is that it remains £13.3bn or 8.3 per cent of GDP – three times the UK figure of 2.4 per cent (£46.2bn) and vastly higher than the white paper's worst case scenario of £5.5bn. 

These figures, it's important to note, include Scotland's geographic share of North Sea oil and gas revenue. The "oil bonus" that the SNP once boasted of has withered since the collapse in commodity prices. Though revenue rose from £56m the previous year to £208m, this remains a fraction of the £8bn recorded in 2011/12. Total public sector revenue was £312 per person below the UK average, while expenditure was £1,437 higher. Though the SNP is playing down the figures as "a snapshot", the white paper unambiguously stated: "GERS [Government Expenditure and Revenue Scotland] is the authoritative publication on Scotland’s public finances". 

As before, Nicola Sturgeon has warned of the threat posed by Brexit to the Scottish economy. But the country's black hole means the risks of independence remain immense. As a new state, Scotland would be forced to pay a premium on its debt, resulting in an even greater fiscal gap. Were it to use the pound without permission, with no independent central bank and no lender of last resort, borrowing costs would rise still further. To offset a Greek-style crisis, Scotland would be forced to impose dramatic austerity. 

Sturgeon is undoubtedly right to warn of the risks of Brexit (particularly of the "hard" variety). But for a large number of Scots, this is merely cause to avoid the added turmoil of independence. Though eventual EU membership would benefit Scotland, its UK trade is worth four times as much as that with Europe. 

Of course, for a true nationalist, economics is irrelevant. Independence is a good in itself and sovereignty always trumps prosperity (a point on which Scottish nationalists align with English Brexiteers). But if Scotland is to ever depart the UK, the SNP will need to win over pragmatists, too. In that quest, Scotland's deficit remains a vast obstacle. 

George Eaton is political editor of the New Statesman.